Profit at large U.S. companies modestly exceeded Wall Street analysts' expectations, while revenue was weak and many companies ratcheted down growth projections.

But stock prices have been rising, with the Dow Jones Industrial Average up 16% for the year and 4.2% since earnings season began April 8 with a mixed report from aluminum company Alcoa Inc.

The developments have added up to a rise in stock-market valuations. The price/earnings ratio on the Standard & Poor's 500-stock index now stands at 14.5, its highest level since 2010.

ENLARGE

The Dow industrials have climbed 16% this year despite soft growth. Above, traders at the Big Board.
Reuters

Stock-rally skeptics said that spells trouble. They contend soft U.S. economic growth and expanding P/E multiples can't coexist forever. Economists predict U.S. gross domestic product will expand at a slower rate in the second quarter than the first, when it increased at a 2.5% annual rate. Government spending cuts known as the sequester came into effect March 1. The Labor Department said Thursday that initial jobless claims increased by 32,000 to a seasonally adjusted 360,000 in the week ended May 11, the largest one-week gain since November.

Ahead of the Tape

MoneyBeat

But many market watchers emphasize there are few other options available for investors. With the Federal Reserve committed to buying $85 billion a month in bonds for the foreseeable future, pushing down interest rates and reducing the income investors can make on assets perceived as safe like Treasurys, many will likely continue pushing into stocks, betting that the economy will continue to improve. "Revenue is not good," said Adam Parker, chief U.S. equity strategist with Morgan Stanley. "But people are giving companies a hall pass for that, because most believe that companies will do better in the second half of the year."

Longtime bulls have been waiting for years for investor confidence in the rally to pick up. Even as shares soared off their March 2009 financial-crisis lows, investors sent only a trickle of cash into stocks despite a recovery in corporate profits. But that has changed this year with the pickup in the stock market and the rise of other riskier asset classes such as "junk" bonds, those issued by below-investment-grade companies.

The increased flows come as the corporate-earnings recovery has plateaued. Of the 458 companies in the Standard & Poor's 500-stock index that have reported results, 70% have beaten forecasts for earnings, in line with the average for the past four years. If results continue as projected, first-quarter earnings will rise 3.4% from the previous year, according to FactSet.

ENLARGE

Meanwhile, sales have come in below forecasts, declining 0.2%, while analysts had expected 0.5% growth. Among companies that have reported, 48% beat Wall Street's projections for sales, below the average of 52% from the past four years, according to FactSet.

"The weaker revenue is tied to the reality that we're in a more moderate growth environment," said Jason Pride, director of investment strategy with Glenmede Investment and Wealth Management, which oversees $23 billion. "Companies are still able to get cost savings…but you can't cut costs forever."

Only 40% of companies saw negative reactions in their share price to earnings reports, the lowest percentage since the financial crisis, according to FactSet.

The S&P 500's P/E ratio of 14.5 is up from 12.7 at the beginning of the year but still below its average of 16.6 since 1999 and below peaks seen in previous bull markets.

Morgan Stanley's Mr. Parker predicts companies in the S&P 500 will earn an aggregate $103.20 in earnings for 2013, flat from last year. But he said investors will be willing to pay more for those earnings. He believes the index will end the year at 1600, 3.1% below Thursday's close of 1650.47.

But many investors appear to think that at current levels, stocks are still a buy.

"How long can you sit, earning nothing in cash, when you can buy [stocks] with attractive valuations?" said Ron Florence, Scottsdale, Ariz.-based managing director of investment strategy for Wells Fargo Private Bank.

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.